The Cost of Inflation

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Two evils lurk in the macroeconomy: inflation and unemployment. The pain from unemployment is obvious, but inflation's is less measurable. Most people realize that rising prices and flat wages imply a decline in living standards, according to a poll taken several years ago by Robert Shiller, an economist at Yale, and presented in "Why Do People Dislike Inflation," a working paper for the National Bureau of Economic Research.

People "are interested in inflation because they think it hurts their standard of living," the report noted. Thirty-eight percent of the respondents said that they are often angry over inflation news, while 48 percent said they were sometimes angered by inflation. Yet, only rarely does inflation outpace wage gains. Okay, every time the Consumer Price Index goes up 1 percent, wages do not-unless you have a Cost-of-Living-Adjustment clause in your contract. Still, the CPI goes up almost every month and wages are adjusted annually. On a year-to-year basis, wages and benefits are growing faster than the cost of living.

Inflation's true pain is felt when rising prices erode the value of savings. Money stashed in financial accounts is not worth as much after prices rise. Inflation results in a significant decline in real net worth.

Next, what economists call "menu costs" come into play. In the early 1980s, when Brazil was experiencing hyper-inflation, restaurant diners would insist on paying when they ordered. Menu prices had to be changed hourly. Thus, the time and resources society spends dealing with constantly changing prices are wasted.

And don't forget inflation tax. Debtors love inflation-it means they repay their loans with dollars that are less valuable than the ones borrowed. Lenders have to charge interest rates high enough to cover the devalued dollars they will be repaid. Since the federal government is a major borrower and households are the biggest lenders, it stands to reason that the government benefits from inflation. Households are hurt-it works like a tax.

Our Index of Well-Being accounts for inflation's effects by adjusting the dollar figures used in its calculation. For per capita income, it's adjusted for inflation as is the figure for per capita spending on recreational goods and services.

In June 1998, the Index held steady at a level of 104.08, compared to a revised figure 104.09 in May. This implies that the typical American is 4.08 percent better off than in April 1990, the base period for the Index.

The income and employment sector slipped from a level of 104.33 to 104.23 in June due to the rising unemployment rate. The productivity and technology sector also fell, to 114.27 from 114.54, due to a decline in labor productivity.

On the upside, the volatile consumer attitudes sector improved to 121.82 from 119.11. Consumers' expectations about their economic futures were up significantly. Finally, the social and physical environment sector rose to 75.83 from 75.67: crime and divorce rates were lower, while the number of endangered species increased only slightly.

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